How Do Bankruptcy Laws Affect Startup Businesses?

Startups are a major staple of economic growth, but also bare numerous risks. According to an article published by the Wall Street Journal, as much as 75% of new startups fail. 


Furthermore, in 30 to 40% of those cases investors lose all of their money. A lot of new entrepreneurs without a good idea, credible insights or proper leadership fail and are often forced to declare bankruptcy. This can raise a lot of concerns for the creditors, investors, employer and the employees. It can also affect a business’ reputation and ruin the trust among the employees should the company choose to restructure under Chapter 11 bankruptcy. All of these factors lead to the company falling apart as soon as the funding is depleted.  

But it does not have to end like this! 

If bankruptcy is considered early as soon as the first signs of trouble appear, the company and your assets can actually benefit from bankruptcy. Bankruptcy effectively halts all investor and creditor collection against a startup while the company gets a second chance to restructure or liquidate its assets to pay off the debts. 

Bankruptcy can allow the startup to sell their assets without any liens, encumbrances or claims. It may also help the company by removing the office lease from the equation. Here are a few useful pieces of advice to consider. 

Bankruptcy Does Not Protect the Owner Personally 

First and foremost, filing a bankruptcy on behalf of your company does not protect you against creditors or investors collecting what they are owed by you personally if you provided them with a personal guarantee. If you operate as a company, LLC or Corporation, your liability is limited. Still, you need to be careful and separate personal from company finances, for example by keeping your bank account separate from the company’s one.  

However, even if you are extra careful to separate your finances, if you were not acting in good faith, the creditors and investors can still go after your personal assets. Startup business owners may also face bankruptcy if a bank determines the owner is out of formula, meaning that your debt to asset ratio requires your bank to call in a loan, as described here:

The Nature of Your Startup’s Funding 

First, you have to determine the rights of investors and creditors. You have to know whether they have an interest in the company or have a collateral in the form of your assets. A creditor that is secured by the startup’s assets has a right to collect 100% from the liquidation of the company assets. A secured creditor may even take the title of the assets without having to pay anything for the transaction.  

An equity investor, on the other hand, receives their payment only after all the creditors have been paid off. That can help your company in case you choose to restructure, as you can work towards obtaining more funding or choosing to restructure your company cooperatively.

Bankruptcy as a Cooperative Process 

Yes, you read that right. You can work together with your investors and creditors towards a solution that will benefit all. This is especially true due to modern bankruptcy laws. A company and the creditors can plan for the liquidation of the assets shortly after filing for bankruptcy through a series of events. The investor may even choose to provide you with funding during the bankruptcy case until you find other sources of finance or schedule the liquidation of your assets. 

Downsides of Bankruptcy 

Of course, the process is not all sunshine and rainbows. There are many downsides to filing for bankruptcy. First of all, it takes a lot of time and money. The processes of liquidation and reorganization are often lengthy and costly, depending on the local bankruptcy laws. The high costs in particular often discourage startup owners from filing for bankruptcy. 

Finally, the role of managers in a bankrupt company is limited. Managers are allowed to work towards restructuring the company in Chapter 11 bankruptcy, but has to report to a committee that represents the rights and interests of the investors and creditors. Furthermore, shareholders may request that your restructuring plan is put to a vote.

Guest PostsLogan Lenz